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Why Energy Storage Investors Must Understand Newton's Laws

Vinod Khosla, the founder of Sun Microsystems and an icon of cleantech venture capital investing, is famous for bluntly telling audiences that "Economics matters, NOTHING that defies the law of economic gravity can scale." This principle is a simple yet self-evident adaptation of Newton's law gravitation to the human condition.

An equally self-evident characteristic of the human condition is explained by Newton's Laws of Motion, which state:

First, that a body at rest will remain at rest, and a body in motion will remain in motion with a constant velocity, unless acted upon by a force.

Second, that a force acting on a body is equal to the acceleration of that body times its mass.

Third, that for every action there is an equal and opposite reaction.

While human beings are far more complicated than physical objects, the reality is we all resist rapid, pronounced, or uncontrollable changes in our lives, our habits and our established rituals, even when the changes might be beneficial. In the final analysis we're all bound by inertia. We praise change, adaptation and progress as desirable goals for others but resist them mightily in our own lives.

By now you're probably wondering where I'm going with the physics discussion so I'll cut straight to the chase. I believe all of the widely publicized forecasts about the future rate of vehicle electrification are wildly optimistic because they ignore the laws of economic gravity and human inertia.

In November of this year JD Power & Associates released "Drive Green 2020: More Hope than Reality?" The JD Power report was widely criticized for being far too conservative in forecasting HEV, PHEV and BEV penetration rates that were less than a third of the rates forecast by the Boston Consulting Group in its January 2009 report, "The Comeback of the Electric Car? How Real, How Soon and What Must Happen Next." When it came out, the BCG report was similarly criticized for being far more conservative than forecasts published by other analysts.

To put things into perspective, the following graph from the Electrification Coalition summarizes the PHEV and BEV market penetration forecasts published by a variety of analytical organizations. The JD Power forecast would have fit nicely between the EIA forecast and the Deloitte forecast.

I created the following graph using historical data on HEV sales from the DOE and forecasts of future HEV, PHEV and BEV penetration rates from the Energy Information Administration (the "EIA") and JD Power.

It's clear to me that the EIA has a good understanding of the laws of economic gravity and human inertia; JD Power has put more reliance on peoples' tendency to praise change, adaptation and progress as ideals for others while resisting them individually; and the analysts from Deloitte through Deutsche Bank have spent far too much time drinking lithium-laced Kool-Aid. I suppose anything could happen, but if I'm putting my money at risk to gamble on an uncertain future, I want to see far stronger forces than hype, public relations, advertising and government subsidies driving the change.

In the last decade HEVs had the benefit of gas prices that rocketed from $1.50 to $3.00 per gallon, they had the benefit of government subsidies, they had the benefit of slashing emissions and they had the benefit of a generally positive end-user experience. When those four market drivers ran into the laws of economic gravity and human inertia, the net result was a 2.35% market penetration rate after 10 years. Nobody believes for a minute that cars with plugs will be as trouble free as HEVs. How anyone can think they’ll be adopted more quickly is beyond me.

I'm convinced that electric drive will be the crushing investment disappointment of the next decade. We're sure to see parlor tricks like Ener1's (HEV) planned sale of 5 MWh of storage to Russia's Federal Grid Company for an obscene price of $8,000 per kWh, but they won't be repeatable without an oligarch pulling the strings. These are not businesses, they're fairy tales.

The only vehicle segment where I can identify a force strong enough to overcome the laws of economic gravity and human inertia are micro-hybrids that use simple stop-start idle elimination systems to reduce fuel consumption and emissions. This market will not be driven by individual choice. Instead it will be driven by EU mandates that require automakers to reduce CO2 emissions to 130 grams per kilometer by 2015 and US mandates that require automakers to achieve average fuel efficiencies of 37.8 mpg for passenger cars and 28.8 mpg for light trucks by 2016. Car buyers will undoubtedly resist stop-start the same way they resisted seat belts in the 1960s and pollution control systems in the 1970s, but it won't make any difference because government mandates have the power to overcome both economic gravity and human inertia. If you want proof of the principle I can do it with two words – CORN ETHANOL.

Regardless of our individual opinions on the issue, micro-hybrids are coming and stop-start will be standard equipment on most new cars by 2020. Roland Berger Strategy Consultants expects 67% of new cars in Europe, 51% of new cars in the US, 60% of new cars in Japan and 30% of new cars in China to be equipped with stop-start systems. In October of this year, Lux Research estimated that 34 million new cars a year will be equipped with stop-start by 2015.

For the foreseeable future, substantially all stop-start systems will draw their power from lead-acid batteries made by Johnson Controls (JCI), Exide Technologies (XIDE), Enersys (ENS) and others. Since automakers are every bit as inertia-bound as the rest of us, their current plans include flooded batteries, enhanced flooded batteries, AGM batteries, enhanced AGM batteries and combination systems that include supercapacitors from Maxwell Technologies (MXWL) and others to meet the extreme demands of stop-start systems.

At September's European Lead Battery Conference, a presentation from BMW, Ford Research & Advanced Engineering and Moll Batterien reviewed the requirements of battery systems for micro-hybrids and discussed various alternatives the industry is considering, including possible upgrades to lithium-ion. It noted that lithium-ion promised better charge acceptance and a potentially longer service life, but concluded that lead-acid was cheaper, more sustainable and avoided several critical issues that can't be avoided with lithium-ion. It then proposed a technology agnostic testing regime for stop-start batteries and showed that anything less than an optimized AGM battery couldn't handle the strain of stop-start applications for more than a couple thousand cycles, which corresponds roughly to the same number of miles.

A second presentation from BMW and Axion Power International (AXPW.OB) showed that even enhanced AGM batteries performed poorly under the proposed BMW-Ford-Moll test protocol and the only device that demonstrated acceptable performance for a typical automakers' battery warranty period was Axion's PbC® battery, a third-generation lead-acid battery that uses carbon electrode assemblies to replace the lead-based negative electrodes used in conventional AGM batteries and is currently in the final stages of validation testing and production process optimization.

While there's little question that micro-hybrids with stop-start systems will be exempt from the laws of economic gravity and human inertia because of government mandates, I don't believe energy storage devices for stop-start systems will enjoy the same status because the buyers of those devices will be automakers. Every storage device that costs more than a flooded lead-acid battery will have to fight the laws of economic gravity. Every storage device that isn't based on lead-acid chemistry will have to fight a century of auto industry inertia. The only real counterbalance will be the desire to avoid warranty claims or recalls arising from stop-start systems that don't function properly because their energy storage systems are inadequate. It will certainly be street-fight for the next few years and while I don't mind cheering for my own team, the victor is far from certain and the only sensible approach for a cautious investor is diversification across the entire range of companies that developing energy storage solutions for this new class of vehicles.

Some of them are going to make a pile of money for their stockholders.

Disclosure: Author is a former director of Axion Power International (AXPW.OB) and holds a substantial long position in its common stock.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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